How Much Slowdown Can Beijing Tolerate?

The once-mighty Chinese economy is now headed in one direction only – downward. GDP growth was 7.5 percent in the second quarter of this year, down slightly from 7.7 percent in the first quarter. In the last quarter of 2012, the Chinese economy grew 7.9 percent. The deceleration from 7.9 to 7.5 percent may seem relatively minor – only 0.4 percentage point in six months. However, when annualized, this figure means that the Chinese economy has lost about one-tenth of its growth momentum since last year.

The question on the minds of most people is how much of a slowdown Chinese leaders can tolerate. Many people, including senior government officials in the West, seem to believe that Beijing will not allow its GDP growth per annum to fall below 8 percent (sometimes one also hears 7 percent as the magic number) because growth below that line is supposed to trigger social unrest. Typically, those who place a lot of faith in this number argue that unemployment will explode once growth stalls. For a government obsessed with domestic stability, that would be a nightmare.

While seemingly persuasive and plausible, the widespread notion that there is one magic growth number that will trigger panic in Beijing is simply a myth.

One reason to dismiss the purported connection between growth and unemployment-based social unrest is the divergence between growth and employment in the Chinese economy in recent years. Because of its investment-driven growth model, China’s economic expansion has been capital-intensive but labor-light. Modern power plants, steel mills, toll roads, and ports are expensive to build, but require a small number of workers to operate. As a result, each additional yuan invested in the Chinese economy is generating fewer jobs. This disconnect between investment-driven growth and job generation can be seen in these numbers. Between 2004 and 2009, Chinese investment in equipment and plants quadrupled, but the number of manufacturing jobs increased only by 15 percent.

Another factor that has greatly alleviated the pressure on employment is China’s aging population. The labor force is shrinking. Consequently, economic slowdown will not result in an instant increase in unemployment. Even in today’s environment of decelerating growth, China’s unemployment has not worsened.

To be sure, Chinese leaders would prefer balanced high growth to low growth. However, the current leadership is aware of the enormous risks of allowing highly distorted growth to continue. Since 2008, Beijing has maintained growth with a massive injection of credit, much of it invested in speculative real estate, excessive industrial capacity, and infrastructure with dubious financial viability. Continuing this disastrous policy would imperil the political future of new Chinese leaders, particularly Xi Jinping and Li Keqiang, who will be up for reappointment in 2017.

That is one of the main reasons Chinese leaders seem to tolerate persistent growth slowdown – so far.